Home ownership is a dream for many, and you shouldn’t let bad credit or a lack of savings keep you from becoming a homeowner. One option is to enter a lease-to-own contract (also called a rent-to-own contract). In this arrangement, you sign a typical lease agreement but also get the right to purchase the home at the end of the lease period. The supply of lease-to-own homes is tiny, so the hardest part might be finding a home you like.

Steps

Part 1

Finding Homes

1

Search online websites. There are many websites with rent-to-own properties listed, but you’ll probably have to pay a subscription fee to use them. Nevertheless, they might be a good investment if you’re struggling to find properties. Some of the more popular online aggregators include HousingList and IRentToOwn.[1]

2

Drive around your neighborhood. Sometimes, owners advertise their homes as rent-to-own on yard signs. The sign should also tell you the monthly rent. If there’s a neighborhood you want to live in, then drive around to check if anything is available.

3

Ask a seller if they’ll consider a lease-to-own agreement. You might find the perfect house, but the seller expects you to get a mortgage and buy it. You can always ask if they will accept a lease-to-own agreement.[2]

Look for homes that have been on the market for a long time. The owner might be especially motivated in this situation, since the house is sitting there, not earning money.

4

Work with a real estate agent to find homes. An agent who knows the local market might have access to rent-to-own listings or might know of people considering this option.[3] You can find a real estate agent by looking in your phone book or checking online.

Part 2

Performing Due Diligence

1

Ask an owner why they are selling. You want to avoid buying a home from someone who is in financial distress. They might default on loans or declare bankruptcy and lose the house in the process. Even though you have a lease-to-own contract, you’ll be kicked out of the house. Accordingly, ask the seller why they are selling.[4]

One good reason is that the seller has moved and can’t sell the house.

2

Do a credit check on the owner. Tell the owner your concerns and request permission to perform a credit check on them. Look for delinquent accounts or a large debt load, which are signs the owner is in bad financial shape. To do this, you’ll also need to know the owner’s income.[5]

You can obtain a credit check from one of the nation’s major credit reporting bureaus—Experian, Equifax, or TransUnion.

3

Pull the property tax records. Visit your local tax assessor and obtain the records on the property. You want to check that the seller actually owns the property. Believe it or not, but scammers often list homes for sale that they don’t even own.

Also check whether there are tax claims on the property.[6] If there are, then the seller might be in financial distress, and they could lose the home while you are renting it.

4

Look for other red flags of a scam. Because lease-to-own sales are rare, they are basically unregulated. Accordingly, scammers often operate in this field, and you should pay attention to signs that a deal might be shady. Look for the following:[7]

The rent is too low. Scammers often try to sell “too good to be true” deals, and below-market rent is one key red flag.

The seller isn’t interested in your credit history. Scammers typically rent to people with terrible credit because they know you’ll never qualify for a mortgage. Instead, you’ll forfeit all of your rent payments.

The seller uses a lease that’s confusing or hard to understand.

The seller charges you an unreasonable amount for an application fee.

5

Have the home appraised. You might not buy the home for a couple years, but you need to do all of your due diligence now. Have an appraisal to confirm that the house is worth what you will pay for it if you exercise your option to buy.[8]

The cost of an appraisal depends on a variety of factors, such as your location and the size of the home. Generally, an appraisal of a 1,000 square foot home can cost around $500.[9]

Get a referral from your real estate agent or check the directory of the American Society of Appraisers.

6

Pay for a home inspection. An inspection will reveal any major or minor problems with the home. Obtain a referral from a local real estate agent or attorney. Typically, you’ll pay $300-600 for a home inspection, but they can save you thousands if they uncover problems.[10]

7

Obtain a title report. Look to see how long the seller has owned the home. The longer, the better. Someone who has been in the home a long time has built up sufficient equity and is probably more financially stable.[11] You can obtain a copy of the title report from a title insurance company.

The title insurance company will likely charge you about $100 for this search.

8

Assess your credit history with a mortgage broker. You might not qualify for a mortgage right now. For example, your credit score might be too low or you don’t have a stable job. However, by the end of the lease period, you’ll need a mortgage if you hope to buy the house. You need to know now whether you will qualify.[12]

Find a mortgage broker and candidly discuss your credit history. Ask the broker if there’s anything in your history that will keep you from getting a mortgage in a couple of years.

Part 3

Negotiating Your Contract

1

Agree to the purchase price. There’s a couple different ways you can calculate the purchase price. Consider which option works best for you:[13]

You can state a purchase price in your contract. Often, this price will be slightly higher than the current market value of the house to account for an increase in value.

You can agree to set the purchase price at the end of the lease agreement when you decide to buy the house.

2

Negotiate an option to buy. You’ll have to pay for the right to buy the home at the end of the lease period. This amount of money is called the “option consideration.” There’s no standard rate, but 3% of the purchase price is common.[14] For example, if the purchase price is $200,000, then the option will probably be around $6,000.

If you choose to buy the house, then you should be credit 100% of the option consideration.[15]

However, if you choose not to buy the house, then you’ll forfeit the option consideration.

3

Avoid “lease-purchase” contracts. With a lease purchase contract, you are required to buy the house at the end of the lease period. This type of contract locks you in, and you can be sued if you don’t go ahead and buy the house. To protect yourself, you should seek a lease-option contract instead.

4

Set the length of the lease. Most lease-to-own contracts last two to five years.[16] Make sure to give yourself enough time to improve your credit profile so you can qualify for a mortgage at the end of the lease period.

For example, you might need to wait three years for a bankruptcy to fall off your credit report. In this situation, don’t sign a two-year lease agreement.

Discuss this time period and the financial strategy you should take with a mortgage broker.

5

Determine the rent. Your rent should be higher than the market rate. The amount over the market rate is called the rent premium, and it will accumulate as you rent. When you buy the property, this accumulated amount will be applied to the purchase price as a rent credit.[17]

For example, your monthly rent might be $1,500. Maybe 20% of the amount will accumulate as your rent credit ($300). After three years, you’ll have saved $10,800.

6

Decide who is responsible for maintenance. The landlord still owns the house, so they should be responsible for maintenance. However, in lease-to-own situations, the tenant is sometimes responsible. You want your contract to state clearly who is responsible for what. Allocate responsibility for the following between you and the buyer:[18]

Routine maintenance, such as mowing the lawn.

Major maintenance, such as repairing the roof.

Homeowners association fees, if applicable.

Property taxes.

Insurance.

7

Review the contract with a lawyer before signing.[19] Either you or the owner can draft the contract. There are sample contracts online you can use. If the seller drafts the contract, make sure to read it carefully and show it to an attorney.

Obtain a referral to a real estate attorney by contacting your local or state bar association.[20] Schedule a consultation and ask the lawyer to review your contract before you sign.

Part 4

Obtaining a Mortgage

1

Check your credit score. You might want to rent-to-own because your credit isn’t strong enough to qualify for a mortgage. However, you’ll eventually need to improve your credit score so that you can obtain a mortgage. Generally, you’ll need at least a 640 to qualify for a conventional mortgage.[21]

You can get a copy of your credit score through websites like myfico.com. Keep in mind that other sites like Credit Karma offer Vantage 3.0 scores, which is not used in mortgage lending.

If you’ve entered credit counseling, then a counselor can get a copy of your credit score as well.[22]

Pay down debts. Nothing will raise your credit score faster than paying off your debts, in particular credit card debt. Create a budget and stick to it. Remember to make monthly payments on time.

Credit counseling might also help you. A credit counselor can help you develop a budget. They can also negotiate with credit card companies to lower your interest rate and to waive fees or penalties.

3

Remove inaccurate information from your credit history. Pull a free copy of your credit report and go through it. Many reports contain inaccurate information, which can pull down your score. For example, an account might inaccurately be reported as closed or in default. Also, your report might contain accounts that don’t belong to you.[23]

If you find inaccurate information, dispute it with the credit reporting agency that has the wrong information. You can dispute online.

4

Exercise your option. Make sure to tell the owner you intend to purchase the house. Read your contract to see how you need to exercise the option. Remember to tell the owner before the deadline.

You might also be able to extend your lease, but the seller will have to agree.

5

Get pre-approved for a mortgage. During the preapproval process, a mortgage lender will review your income, assets, and monthly debt obligations. Complete a mortgage application and provide supporting documents, such as your pay stubs, W-2 forms, and bank statements. If approved, you’ll receive a letter telling you how much you can borrow.[24]

Obtain pre-approval no more than 60-90 days before the closing. The approval is not valid past that point.

6

Close on the house. Before a bank will lend you money, they will need to perform due diligence: appraisal, inspection, etc. You will review the terms of your mortgage and any disclosures from the seller about the condition of the house. Ideally, you can close within 45 days of exercising your option.

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Tips

Before signing a rent-to-own agreement, you should meet with a HUD-certified housing counselor to review your options. For example, there are programs available that help renters transition to home ownership without requiring you to sign a rent-to-own agreement. Call 800-569-4287 to find the nearest counselor.[25]